Friday, November 30, 2012

Steve Keen and Pontus Rendahl did a very rare thing. they had an open debate between an heterodox and a mainstream economist. Worth checking it out. Keen linked to the audio here. Rendahl calls it a debate between Keenonomics and Metrodox Equilibrium (see here), whatever that is. If you ask me Rendahl shows the same confusion that most younger -- by which I mean educated post capital debates, and once the new notion of equilibrium (intertemporal short term equilibrium, without a uniform rate of profit) became dominant -- mainstream economists seem to be stuck with (see my previous post too).

Guillermo Calvo wrote a post on what he thinks is the new macroeconomics. Minsky gets cited, but that's pretty much the only concession to heterodox macroeconomics. The interpretation of what the "new" macro for the 21st century should be is basically New Keynesian price/wage rigidities models cum debt-deflation (the finance and Minsky part). But even the understanding of debt-deflation is limited to the notion of sudden stops (slowdown or reversal of capital inflows).

According to him:

"many of us have been involved in developing and testing theories in which imperfections in financial markets play a central role – and coining new terms like Sudden Stop and Phoenix Miracles. The dominant view, however, was that financial crises in EMs reflected weak institutions in that part of the world, and could not possibly take place in advanced economies. Unfortunately, the subprime crisis revealed, to the dismay of many in advanced economies, especially in Europe, that the world is more uniform than we thought!"

In other words, he seems to think that market imperfections are pervasive and that developed countries are vulnerable to sudden stops, like emerging markets (a terrible name popularized in the 1990s for developing countries, as if the only thing were the 'markets'). Note that while developing countries have not experienced sudden stops with the financial crash of 2008, and have used international reserves to insure against the volatility of financial markets (and often introduced capital controls too, when those were not already in place), no significant sudden stop affected the US, the epicenter of the crisis.

As noted by several heterodox economists the crisis in the US the deep causes of the crisis were associated to wage stagnation (worsening income distribution) and the associated increase in private debt, which led to a collapse of spending in the aftermath of the Lehman crisis. Mind you, at that point capital flows went into Treasury bonds, and no sudden stop affected the American economy (in contrast to say Argentina in 2002). So no, the world is not flat or "more uniform" that Calvo thought.

Just for those that might not remember, on dollarization this is what Calvo (paper with Carmen Reinhart) used to say back in 2000 (a few years before the Argentinean crisis; he was rumored as a possible finance minister at the time in Argentina, and the notion was that he was for dollarization):

"Exchange rate movements are costly in this environment. If policymakers take a hard look at the options for exchange rate regimes in emerging economies, they may find that floating regimes may be more of an illusion and that fixed rates--particularly, full dollarization--might emerge as a sensible choice for some countries, especially in Latin America or in the transition economies in the periphery of Euroland."

The sensible choice was dollarization (sic)! Note that his point was that with sufficient fiscal austerity, credibility would be restored, and capital would flow in the right direction (if you are from Greece, you should be afraid if this is the 'new' macro).

But back to sudden stops, which is the basis of his claim to have introduced financial markets into modern macro, here is what he had to say in his post, about the puzzles ahead:

"As recent empirical research has amply demonstrated, financial crisis follows credit boom; this is somewhat of a puzzle, but the most challenging puzzle in my opinion is that credit flows (both gross and net) increase in the run up of crisis, only to crash precipitously after the crisis' onset. ... In other words, if herding is the key word, forget about microfoundations of macroeconomics. I must confess that I am not ready to take such a radical stance. My view is that perhaps this very puzzling phenomenon is linked to liquidity and, more to the point, endogenous liquidity, a phenomenon that has been largely ignored in 20th century macroeconomics."

In other words, sudden stops are associated with collapse of liquidity, and those might be associated to herding behavior, which is irrational and is not amenable to formalizing microfoundations along conventional lines. There are so many misconceptions in this quote that one wonders when is he going to get the Sveriges Riksbank Prize (the often referred to as Nobel).

Endogenous liquidity, or endogenous money is no puzzle, and in fact, mainstream models that accept a Taylor rule have basically incorporated it, like Wicksell. Herding is not that complicated to understand, and is NOT the main problem with microfoundations. The problem with microfoundations is not lack of rationality of economic agents, but the fact that even with very rational (even by the limited mainstream standards) you cannot prove that markets lead to full utilization of resources, with flexible prices and full information (yes please go read on the capital debates).

Note that the effects of debt-deflation on demand are not discussed by Calvo. Or income distribution for that matter. Let alone the recognition that the idea of a natural rate is very difficult to defend, and I don't even mean logically, just empirically after this crisis. The essential information out of this piece is about the degree of confusion of the mainstream. It is increasingly clear that that we are living in a period of decadence of economics as a science, in which the profession is dominated by Vulgar economics.

Wednesday, November 28, 2012

Dean Baker has suggested to Krugman that one reason for the lower productivity in Italy is that actual employment was higher before the euro, or if you prefer disguised unemployment was rampant. Then with the entry in the euro several workers that were not legally hired were, and as a result it only seems that productivity fell a lot. That is, it looks like a lot more workers are not doing that much more in terms of production, when in fact the actual increase in employment was not that large, and, hence, the fall in productivity not as big. Certainly an interesting possibility. Below the employment in Italy and in France compared (1970=100).

Note that, in fact, up to the 1980s employment grew faster in Italy than in France, and by the mid-1990s this trend was reversed. While it is true that in the late 1990s, with the euro, it seems that employment again grew faster in Italy (which may be due to Dean's suggestion), note that the proportional increase is relatively small (about 3.9% with respect to France from 2000 to 2006), and has reversed since the crisis. It seems that most of the fall in productivity is real, and caused by the fact that Italy grows less. Again, I think these reflects overly restrictive policies and reflects the well know regularity known as Kaldor-Verdoorn Law.

Tuesday, November 27, 2012

Krugman has noted in a recent post that productivity in Italy, when compared to France, has been dismal, particularly since the late 1990s, after the launch of the euro. He correctly points out that the size of the Welfare State should not be the main culprit, since in France it is also large (larger according to him). The graph below shows the real GDP in both countries (1980=100) in domestic currency.

Note that since the launch of the euro Italy's GDP is considerably below that of France. In other words, Italy has grown considerably less than France since 1999. The real rate of growth of France was around 1.6% while that of Italy was closer to 0.7%. It should come as no surprise for those that think that the evidence is strong for the Kaldor-Verdoorn Law, which says that productivity results from the need to innovate when the economy is close to full employment, that productivity is higher in France. It's the lack of demand, caused by restrictive policies and the need to reduce debt in Italy, that explains the lower levels of productivity. Blame it on the euro!

PS: Just for fun, below the graph of Real GDP in Italy (Output) as a share of the French. Go back to Krugman's graph and see the similarities.

Jamie Galbraith argues here (he appears at around minute 10) that there is no economic reason to be concerned about the fiscal cliff, and that the cause for the 'crisis' is that certain groups want to roll back social spending.

Dear students and colleagues, ladies and gentlemen, companeros y companeras (if I am allowed to say so), I wish first of all to thank the organisers and the supporters of this event. I believe this is a beautiful opportunity to work side by side with the young people who are fighting against the present state of things and the critical economists. This is not a conference against Europe, or of one part of Europe against the other. As people of “troubled Europe” we feel perhaps more concerned than the majority of our northern fellows. But I think that the message of this meeting should arrive especially at your young northern fellows not just asking for solidarity (a word that I personally look suspiciously at), but because the dismantlement of the social rights in our countries might be the premise to the reduction in their own. I believe that they would defend the idea of their countries being part of a peaceful and prosper continent, and be outraged by the idea of their countries as islands in the midst of deprivation and resentment. I also believe that youth is the time of hope and generosity, the time in which the outrage for social injustice is felt the most. So I hope that our messages, the messages from the young people here, will arrive at the most sensible ears of northern Europe, those of the young people there (let us not forget here the young socialists massacred by the crazy Nazi guy in Norway). It is particularly important that, through any possible channel, more information about the situation in our countries be directed at the likely victims of disinformation, be they youths of Germany, Austria, the Netherlands etc,. We should take some initiative in this direction.

The story of the crisis
The story of this crisis is the story of an imperfect currency union. It is not yet clear to me which political processes led to the European Monetary Union (EMU). Unfortunately economists tend to neglect the analysis of the political processes, and indeed our aim is also to reform the way Economics is done and taught. From a rational point of view, the national leaders and their economic advisors certainly knew that the European Union was not a so-called optimal currency area. Various considerations possibly led to this imperfect union. France and Italy were not happy with the European Monetary System (EMS), the fixed exchange-rate that preceded the EMU: they though that a monetary union could be less German-dominated than the EMS. The German unification in 1989 and the fall of the iron curtain possibly accelerated the process (Germany has traditionally looked east, and the monetary unification was perhaps seen as a way to lock it west, but I cannot judge if this is a legend). Finally, through the common currency the elites in the periphery wanted to import the German renowned labour discipline. Be that as it may, the monetary union lacked the institutions that could make it work, in particular the significant federal budget with regional redistributive functions recommended by earlier unification plans (see also the prescient analysis by Kaldor and later by Godley). The union was designed in negatives, so to speak. To prevent national governments to take too advantage of lower interest rates, the Maastricht Treaty created the famous Maastricht fiscal constraints; the ECB was assigned a monetarist statute with the sole objective of controlling inflation (so that it inherited the Bundesbank function to keep German wages in check). The objective of full employment was assigned to national labour-market flexibility policies, that is to competitive internal devaluation strategies. No to a wider federal budget, no coordination of fiscal and monetary policies, no banks crisis resolution mechanism.

As we know, at the beginning the Euro seemed a success, particularly if judged from the point of view of Spain, Ireland and also Greece. Not much so for Portugal and Italy: the former country already had its demand-led boom in the years before the monetary unification and joined the currency with a negative current account, which explains its later stagnation. Portugal and Italy - but of course this partially also concerns the other southern countries - likely began to suffer from a loss of competitiveness due to more than one factor: an over-valued real exchange rate, the competition from the EU new entrants and from the emerging economies, the stagnation of domestic aggregate demand that depressed productivity growth In Portugal and Italy. As is well known, in Spain, Ireland and also Greece domestic demand was indeed sustained by a construction boom fed by foreign capital flows. The story has been usefully compared to that of the financial crises in the emerging economies: financial liberalisations and fixed exchange rates can easily lead to foreign capital flows that sustain a residential investment-led growth, ending later in a balance of payment crisis. This happens when foreign financial investors stop the refinancing of the peripheral foreign debt and begin to withdraw their investment (what is named “sudden stops and capital flows reversal”).

The peculiarities of the Eurozone (EZ) payment system, the famous and arcane TARGET 2 system, have impeded the eruption of the standard foreign debt crisis, with attendant debt restructuring and currency devaluation, which has been typical of the emerging economies. In this kind of crisis, typically the IMF intervened to assure that the indebted countries could continue to repay the interest and the principal of their foreign debt (so the IMF “saved” the banks of the north); normally the debt was renegotiated; fiscal austerity measures were imposed to obtain a current account surplus necessary to assure the future ability to serve and repay the debt (including that to the IMF); the currency devaluation relieved a bit the country in this effort. Notoriously, Argentina by refusing to repay 75% of her debt avoided the IMF austerity measures and, also helped by a buoyant price of her exported commodities, could manage a demand-led recovery. What has happened in Europe is that, through TARGET 2, the foreign debt of the peripheral countries has “changed hands”: from a liability towards private lenders (who withdrew their loans) it has become a liability towards the Eurosystem (the German conservative economist Werner Sinn has not been wrong in calling it a “stealth bail-out” of the periphery, although he missed to point out the German responsibility in this story. I also agree with him that this re-shuffling of liabilities has not made the German credits safer, contrary to the initial opinion by De Grauwe). In a sense TARGET2 helped to gain time, but this time has so far been wasted by the EZ governments. While no reforms of the institutional architecture of the EZ have been endeavoured, the EZ followed a wrong diagnosis of the crisis that, through austerity, made things much worse.

The peripheral governments have indeed basically backed the German interpretation of the crisis as caused only by the borrowers ( although the SPD also vaguely accuses the deregulation of the financial sector) and by the fiscal profligacy of the peripheral governments. This interpretation overlooks that the peripheral current account deficit financed by the northern capital flows sustained imports from core-Europe. Moreover, it forgets that the fiscal crisis was the result, in Ireland and Spain, also of the bailout of private banks, while the Italian public debt was much older and Italy before 2008 violated the fiscal pact much less than Germany and France. While the Greek centre-right government might have relied too much on an endless cheap foreign support to its public debt, it should not be forgotten that Greece has also been a excellent market for German exports (and possibly still is for the German and French armaments). Be that as it may, lenders are as much responsible as borrowers. But core-Europe is responsible for the crisis in an even more important way: its neo-mercantilist behaviour. The financial liberalisation and the fall in the devaluation risk (the ‘convertibility risk’ as Draghi calls it) and the consequent indebtedness of the periphery have indeed been functional to this behaviour.

This is an old story, indeed. Since the early 1950s Germany took advantage of fixed exchange rates to pursue an export-led mode. The three institutional pillars of the German low-inflation model were

- a paternalistic State, both with regard to the general welfare of the working class (the famous Bismarkian social state) and to trade (the German government has clearly foreign trade and foreign investment policy as its top priority, as the resignation of one President of the Federal Republic reminded to us: he candidly confessed that Germany sent troops to Afghanistan for commercial reasons).

- an accommodating labour movement;

- the Bundesbank as the watchdog of German labour discipline.

Wage moderation, the relative compression of the domestic market and the other countries’ Keynesism made the model successful: it has guaranteed a high standard of living in a self-fulfilling model in which the pursuit of trade surpluses promoted domestic labour discipline. The model was reinforced at the inception of the Euro by the SPD-inspired labour reforms. Although the model assured relatively high wages, following Kalecki we can regard it as a way for capitalists to maximise the level of the “internal surplus” - that is of what remains to them of the social product after having paid wages - and get rid of it (or realize it in Marxian terms) in foreign markets.

Note the parallel here between the U.S. and the EZ crises. In both cases residential investment bubbles (and more in general autonomous consumption financed by consumer credit) within a currency union sustained aggregate consumption from a middle class otherwise impoverished by decades of real wages stagnation. The internal geography, so to speak, changed, but the logic is similar. What is different is, of course, that the U.S. as a complete Federal Union had the will and means to deal with the crisis through monetary and fiscal policies and by implementing bank crisis resolution mechanisms, while the EZ as an imperfect Union retreated back to nationalistic behaviours.

There is a lot of things we must imitate from Germany – and the German people should in no way be regarded here as an enemy. There is a ‘benign’ form of mercantilism (quotation here) that consists of a developmental state promoting welfare and productive capacity. This form of economic nationalism is not at odds per se with a domestic demand-led growth and international economic cooperation. But the German hyper-nationalistic economic model has always constituted a problem for the world economy, and it is basically incompatible with the working of the EZ. This has been defined as malevolent mercantilism (quotation here). The suggestion that all the EZ countries should imitate Germany is a zero-sum game: a suicidal competitive deflation strategy. As Soros summed up, Germany has to lead or to leave.

As I said, I believe that we should decide here a strategy of communication with the German new generations, the only ones that perhaps have not yet suffered for too long from the Build, FAZ, BuBa etc. brain washing. Our student organizations should ask their German twins to be invited in the German Universities to explain the dramatic situation in our countries and the importance of a collective responsibility to bring Europe away from this self-destruction. A specific open letter might be prepared in this meeting in this direction and addressed to the main German Youth organisations (including the SPD’s Jusos, LINKE, Grunen etc.) The rich and generous German progressive foundations might be asked to finance this initiative: one hundred delegations from PIIGS countries to visit one hundred German universities. Germany has to decide if she wants to lead a prosperous Europe or if she just wants a backyard of impoverished countries, possibly a pool of unemployed labour for her ageing population. We must be competent enough to explain the terms of the situation to our German fellows, and so it is important that the interaction with the critical economists continues. It is also important that the European dimension of the crisis is fully endorsed by the movements.

In view of the German neo-mercantilist behaviour, a debate about the causes of the EZ trade imbalances has developed: one thesis emphasizes the structural lack of southern competitiveness often attributed to an unsustainable wage dynamics; more plausibly, another thesis argues that the trade imbalances are mainly due to the combination of the repressed German domestic market and wage moderation, and of the residential-investment demand-led growth in some peripheral countries. This led to higher inflation in the latter and to their loss of competitiveness. In this view, real wages are not the cause of the higher inflation and real exchange rates losses, rather the service/non-tradable sector, protected from external competition, appears to be the cause. Spain seems the typical example (the PIIGS families, as the Anna Karenina unhappy families, are each miserable in her own way, so it is always difficult to generalise). This debate is important to focus on – also in view of some discussion that has taken place on the manifesto of the meeting (I particularly sympathize with the comments by Jorge Uxo). What Europe seems to need is not so much a structural change in the periphery, but rather a German-led aggregate demand growth. This would help to rebalance the EZ. Inspired by an analysis of the periphery problems as due to too rigid labour market institutions and too high real wages – again a wrong diagnosis of the crisis – the widespread labour market reforms and wage deflation have negatively affected consumption demand, thus aggravating the crisis.

All in all, the way Europe has dealt with the crisis has been too little and too late (to kick the can down the road, as it has often been said). But even worse: the austerity imposed on the EZ has made the crisis worse. It may well be said that at present austerity is the main cause of the crisis.

The policies
The main policies so far have been:

a) Bail out packages (ESFS; ESM): used to bail-out Greece, Ireland and Portugal. They have a basic problem: the troubled countries also put the money, so Italy and Spain “loaned” money to their smaller troubled fellows to save the German banks (note that Germany lends at very convenient rates, and borrows also at very profitable rates, the opposite is true for Spain and Italy). Anyway, Spain and Italy cannot save themselves in case they need to be bailed out (it would be a vicious circle, somebody drowning cannot help herself): so the only real money would be from Germany: too much even from this mighty country. To make things worse, the bailed-out countries have been imposed a counterproductive austerity that made the crisis and public finances worse. Presently, everybody is realizing that Greece will not able to redeem the official loans it received (used to save the French and German banks). OSI (Official Sector Involvement) is the new EZ-acronym.

b) The ECB intervention has been limited to the early summer 2011 when the central bank bought about €200bn of peripheral sovereign bonds, without any persistent effect on the sovereign spread. Only an unlimited guarantee can obtain this result.

c) The liquidity made available by the Eurosystem assured that the banking system in the periphery did not collapse in view of the capital flights to core-Europe. As said, the liabilities of the periphery towards the private core-European investors have been substituted by the “official” TARGET2 liabilities towards the Eurosystem. Since most of the capital flights consisted of previous investment in peripheral sovereign debt that foreign investors progressively refused to refinance (roll-over), banks used the liquidity to sustain their respective domestic sovereign debts (In Italy, for instance, the share of foreign-held public debt has fallen form 60 to 30 per cent. This does not mean, however, that the Italian foreign debt has fallen: private loans have just been substituted by TARGET2 loans). What all this produced is that fragile banks sustain fragile states, and fragile states back fragile banks. What we would instead need is an ECB support to sovereign debts and a bank resolution mechanism: a European bail out of banks and deposit insurance (measures that cannot be left to national governments). Both measures would not hit the core-countries tax-payers as far as the intervention of the ECB keeps the sovereign interest rates at bay. The results of the European summit held at the end of June 2012 have been disappointing in this regard: no European banking crisis resolution mechanism seems to be in view.

d) From Summer and Autumn 2011 also Italy and Spain were inflicted various austerity packages. Italy was imposed a change in government with the implicit promise of an ECB intervention that never materialised. In addition, in Spring 2012 the EU approved the six-pack and the fiscal compact directing the EZ countries to balance their budget and to reduce the sovereign debt/GDP ration at 60% by year 2020. The logic of the austerity policy is as follows, austerity leads to credibility, which leads to lower interest rates on sovereign bonds and thus to recovery.

As a mounting evidence is showing, this option simply does not work and will not work.

e) Following his famous August declaration (“The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”) in Sept. 2012 Draghi launched his OMT plan [Outright Market Transactions is the way the ECB defines the open market operations (OMO); in the ECB’s jargon OMO means bank refinancing operations]: the ECB cold intervene in the secondary markets buying, in principle, an unlimited amount of sovereign bonds (the big bazooka, although restricted to up-to 3y bonds); the countries asking for assistance should, however, subscribe to an austerity memorandum with the EU surrendering their national fiscal sovereignty. The idea of OMT is that lower interest rates will render austerity a bit less tough, so that unsustainable social unrest (so-called “austerity fatigue”) can be avoided, credibility regained, and maybe - the trust of financial markets being restored - some growth will appear, etc. The ECB will not pre-commit a given interest rate (or a given level of the spreads), so as to be able to blackmail in any moment governments, and anyway the reduction should not be too much, with a view to avoiding moral hazard, that is the temptation of dodging the “structural reforms”, cuts in public spending and labour market reforms. So the OMT does not really break with austerity policies asking the peripheral countries to surrender further national sovereignty to Bruxelles.

As known, the mere announcement by Draghi of this measure determined a fall in the Spanish and Italian sovereign spreads of some 150 basic points. This made plain to the public that the interest rates are determined by the central bank and not by the market, unless the central bank does nothing. It also showed that it is not necessary for the central bank to intervene and buy: the deployment of the big bazooka is enough to intimidate the markets.

We should finally mention the blah blah going on in Bruxelles on a European Federal Budget, nothing very serious, some bland anti-cyclical fund, nothing to do with a real redistributive Federal Budget (in fact, the existing small EU budget has been cut!). Indeed when Germany thinks of a European fiscal policy, it is just proposing the assignment of a pro-austerity power on national sovereign budgets to a fiscal authority in Bruxelles.

Alternative policies
Alternative policies have also been proposed and discussed.

Eurobonds
In my opinion Eurobonds are not an ultimate solution since by putting all sovereign debts in the same pot, the “credibility” of the German sovereign debt would be negatively affected and the political support by Germany undermined. A pan-European sovereign central bank that guarantees a European sovereign debt is the necessary measure to avoid this result. But if the ECB provides this guarantee, do we still need the Eurobonds? Perhaps yes, if the change in the statute of the ECB is deemed to be accompanied by a centralization in Bruxelles of fiscal policies. But this should not be done along German lines, however. The old French proposal (not of shy Hollande, tough) of a stronger Eurogroup that should be transformed from an informal club into the institutional fiscal counterpart of the ECB would be a good compromise to avoid an EZ fiscal Kaiser (the Germans have always refused this change because a political body would be stronger than a technical body like the ECB).

An alternative proposal
My favourite proposal is of an ECB intervention to calm markets down (the big bazooka) conditioned by a fiscal rule; this should consist of the stabilisation of the public debt/GDP ratios (not their reduction). This will be consistent with deficit spending policies. I would call it an “expansionary conditionality” or “Keynesian conditionality”. The rationale is that the savings obtained from the reduction in the interest rates should be used not to reduce sovereign debt/GDP ratio, but to sustain aggregate demand; the larger fiscal revenues will help the stabilization of the ratio. This is the most practical, politically reasonable proposal I can think of.

In addition we need:

- a solution to the banking crisis and a separation of sovereign and bank crises (this would be easier if the European state intervention is backed by the central bank)

- a looser wage and inflation policy, so to let wages rise especially in core-Europe in order to sustain aggregate demand. To this scope we need the right institutions, first of all a cooperative ECB that tolerates a higher inflation target and stops for good being the watch-dog of German wages. Instead of destroying the Trade Unions, the EZ south needs strong TU and income policies, plus measures to modernise the non-tradable sector, the source of the core-periphery inflation gap.

Many other things we need to do, but I do not like endless shopping lists. Let us focus on the macroeconomic measures first.

There are at least two further, opposite alternatives to be briefly discussed, a Federal Europe and a Euro break-up.

A Federal Europe
Optimistic Europhiles are thinking of the crisis as an opportunity to create a Federal Europe. The US could be a good example for a working Federal State from the point of view of fiscal and monetary policies, although less for social policy. We may, of course, dream of a progressive Europe, with social fairness and full employment. Of course Treaties in this direction should be re-written (including the ridiculous EU “Constitution” that says that the ECB must be independent and pursue price stability first). A Federal Budget should progressively be created, perhaps along the lines of the McDougall report of 1977. But I suppose this is not for this generation. The Spanish experience with Catalonia shows how much even old and consolidated states are fragile once exposed to external shocks (the austerity has clearly generated the Catalan resentment against the rest of Spain – that is, by the way, a market for Catalonia, as the Italian Mezzogiorno is for the Italian north).

A Euro Break-up
I am not able to assess how dramatic this event could be, there are different opinions. What is sure is that there should be a preliminary European political agreement, and a lot of peaceful financial negotiation later. The EU must be saved. A German exit might be easier, but do not underestimate the governance problems of a Southern Euro. We must study this, and our governments should study it to have a card to play to deal with Germany. It is clear that Spain, Italy and the other smaller southern fellows cannot endure this situation any further. We must therefore accompany our “reasonable” pro-European proposals with the option that we might go “our way” (a Mercosur with preferential ties with Latino-America and North Africa?).

Our duties
We have a difficult future ahead. But our fathers and grandfathers also had a difficult future ahead. I thought I belonged to a lucky generation that did not suffer hunger and wars, and the same I expected for my sons. It is not anymore true (at least we have not wars, yet). I assumed to be living in a situation in which any single individual was cared by society. It is not true anymore: we see a cynical ruling class, that includes Rajoy and Monti, literally destroying the lives and hopes of entire generations, old and young people alike. But we must fight and resist. Our specific duty as students of Economics and critical economists is to put the European question at the centre. The current European leaders must decide if they want to save Europe or not. They are the anti-Europeans, not us. We must explain to our fellow citizens that austerity is a policy choice and not a compelling fate, that different policies that would save Europe and prosperity are feasible. You must talk also to your young core-European fellows. If I am sceptical about solidarity, youth is the time for solidarity and change. I am sure they will listen. To do this, we must also fight to defend the space for critical economic thought in our universities. The Italian students of LINK have in this regard launched a petition that they will explain. We must defend critical Economics so as to be better trained in view of the tremendous challenges we have ahead. Good luck to all of you, and thanks.

* I thank Jorge Uxo for preliminary comments and Giancarlo Bergamini for valuable help in improving the exposition.

Roundtable remarks at the ESHET conference in Buenos Aires, with Eduardo Crespo and Franklin Serrano (h/t Alejandro Fiorito and Revista Circus). The very last remarks are in the additional video below.

Wednesday, November 21, 2012

This was the topic of the RBI/ADB conference in Mumbai. No particular surprises. The consensus is that capital controls affect the composition of flows, but not their volume, and even the IMF, represented by Jonathan Ostry, suggested that capital controls should be part of the tool kit used by central banks. Also, some skepticism on the efficiency of short term (or episodical controls, such as the ones used by Brazil) was raised. Of course there are still differences on what circumstances capital controls are actually necessary.

Most of the discussion was related to the use of capital controls to reduce the risk of appreciation, since in the last decade developing countries have had to deal with inflows and a depreciating dollar. Note, however, that capital controls were not thought when originally defended by Keynes and White at Bretton Woods to be necessary for reducing appreciating tendencies, but to limit capital flight (and avoid and external crisis) and provide monetary autonomy (Impossible Trinity or Trilemma).

Further, in historical perspective, exchange controls (capital controls on quantities not prices) have been used as an instrument for industrial policy, to determine that the use of dollars is prioritized for capital equipment imports particularly in the periphery. In that sense their use is in fact an essential an permanent tool in the developing economy set of instruments, and that's why signing FTAs or BITs that reduce the ability to deploy capital controls is dangerous.

PS: On the long standing issues related to capital controls and exchange rate regimes see this paper.

In Mumbai for a conference sponsored by the Reserve Bank of India (RBI) and the Asian Development Bank (ADB). On my way, I read an op-ed by Arvind Panagariya in the Times of India, in which he defends that the Bharatiya Janata Party (BJP) should embrace the reform agenda, followed by Congress and by the same BJP when in power. His views [remember that Panagariya is a fairly conventional free trade mainstream economist] are fairly conventional, but interestingly he suggests that "the Indian public today fully appreciates the benefits of reforms."

The notion that the majority of the Indian people are for the Washington Consensus reforms is surprising to say the least. The basis for his proposition is very flimsy indeed. He suggests the following:

"The opposition parties had claimed that the latest package of reforms would damage millions of shopkeepers (FDI in retail), transport workers (diesel price hike) and urban households (subsidised LPG cylinders). Yet, none could translate that supposed harm into sustained anti-reform demonstrations in the public space."

In other words, the evidence for the support for the reforms is the lack of protests on the streets against the reforms. It is far from clear, however, that the absence of protests are a sign of support. Note that for good or bad the Indian economy, even with a slowdown, continues to grow fast, so it would be surprising to find a lot of protesters in the streets.

And yes India has been growing relatively fast since the 1980s, that is a whole decade before liberalization started in 1991. Also, note that one of the key areas in which India has not followed the liberalization and deregulation policies of the neoliberal agenda is in the financial sector, preserving capital controls (even if there have been pressures and a certain amount of liberalization it is way less than what happened in Latin American economies, for example).

The current debate in India has been very heated, following the revelations that Wal-Mart has paid bribes (as much as it happened in Mexico). At any rate, the process of liberalization proceeds with parties being for once in power, but against when in the opposition. This system has been perfect in order to guarantee that no matter who wins the elections, yes this is the largest democracy in world, the process of economic liberalization is not affected.

PS: On a slightly different matter, the RBI study has an interesting study that shows a 10% increase in minimum support price (MSP) of wheat raises wholesale inflation by 1%. That is, price controls, in this case on food supplies, is an important element of anti-inflationary policy in India.

Friday, November 16, 2012

Earlier this year I had posted on Triplecrisis a critique of the mainstream views of the crisis, pointing out that they were still lagging behind the heterodox discussions and had much to gain from incorporating the insights of progressive economists. One of the surprising things about the readings I did for that post was that Robert Shiller actually was not very prescient about the housing bubble. In the famous paper with Karl Case he argued, as I noted, that: “judging from the historical record, a nationwide drop in real housing prices is unlikely, and the drops in different cities are not likely to be synchronous: some will probably not occur for a number of years. Such a lack of synchrony would blunt the impact on the aggregate economy of the bursting of housing bubbles” [emphasis added].

Now, I'm reading Tom Palley's latest book, The Economic Crisis: Notes from the Underground, and discover that the phenomenon is all too common. He notes (p. ix) that Raghuran Rajan, the ex-chief economist at the IMF, whose paper at Jackson Hole in 2005 was lionized as predicting the limitations of financial innovation in the famous film Inside Job, actually says in his conclusion that he: "believe[s] the changes have, in general, expanded opportunities significantly and have, even on net, made the world tremendously better off. But opportunities can be used for good and for bad" [emphasis added]. Note that if financial innovation has made the world better off, as he concludes, it cannot be that he thinks it has increased risk. However, in the film Rajan said this: "the title of the paper was, essentially: Is Financial Development Making the World Riskier? And the conclusion was, uh, it is." Yep, he should get the Mishkin Prize (awarded after he changed the title of his paper from Stability to Instability).

There are several other interesting cases of oracles that did not predict anything, and of mainstream economists that when they did predict the crisis, they did it for the wrong reasons and got the story and the consequences incorrectly (all bring up more stories from Tom's book in other posts). The essential point that Tom makes, however, is a sociological one, that helps understand the predominance of the mainstream paradigm. The profession suggests that, while predicting the crisis was impossible, a few illuminati within the mainstream did foresee everything, and as a result there is no systemic problem with economics as a science. No need for revolutionary change in the profession.

Levi-Strauss once said that myths are totalitarian stories that eliminate all possibilities of doubt, since they explain everything. In this case, the myth of the lone, foresighted, neoclassical economist preserves the culture of complacency in the profession with the utter irrelevance of mainstream economics.

Thursday, November 15, 2012

The Eurozone crisis has been reduced, according to the mainstream diagnosis, to a fiscal crisis caused by excessive public spending and a competitiveness gap between North and South. The mainstream solution is to close this gap by means of ‘expansionary fiscal austerity’ and wage reductions. This has been admitted even by the IMF to be a dead end.

In our opinion the root of the Euro crisis lies in both the inadequate institutional set up of the Eurozone, which lacks a genuine lender of last resort and sufficiently coordinated fiscal and wage policies, and on an over-liquid and under-regulated international financial market that was more than happy to finance any imbalance - no matter how unsustainable it was.

What we had in Continental Europe were mutually dependent models of growth. The mercantilist export-led growth of the North could not have been sustained without a (remarkably easy-to-finance) debt-driven model in the South, accumulating trade deficits and private and public debt. In the aftermath of the financial crisis, the private debt was turned into sovereign debt. The Irish case is an extreme example of this process. The ensuing austerity policies enforced upon the governments increased unemployment to a socially unacceptable level. If continued these policies will lead to a prolonged depression and even more social unrest.

European institutions were and still are not able to deal with such structural imbalances in an adequate way. Mass unemployment and social deprivation resulting from austerity policies is threatening the survival of democracy in the European Union.

Alternative perspectives

On the basis of our diagnosis we are convinced that Europe should reverse the current austerity policy regime. This would require profound institutional and policy change.

In terms of monetary policy, we believe that ECB should act as a credible lender of last resort to relieve the sovereign debt crisis. Strict regulation of financial markets is a further step, and it is necessary to separate investment banking from commercial banking.

In terms of fiscal policy, the link between the ECB and fiscal conditionality should be fundamentally changed. Monetary policy should support and accommodate progressive fiscal rules aiming at employment creation and growth. Budget deficits can only be consolidated in a growing economy.

These growth stimulating policies are consistent with the desired long run stabilization of debt-to-GDP ratios. In the present situation of mass unemployment, these policies do not carry a significant risk of inflation.

We also believe that the adjustment has to be supported by stimulation of consumption via higher wages starting from the core surplus countries (like Germany) where wage restraint policies have considerably contributed to the growing income inequalities and current account imbalances in the Eurozone.

If the German finance minister believes in what he said, that no country can live forever beyond its means, then it must also be clear that no country can live indefinitely below its means. This implies that the change in the wage policy in Germany has to be an important part of the solution.

Mutual prosperity of the Eurozone countries and their citizens through demand expansion, rather than demand contraction through fiscal consolidation for the benefit of high finance, must be recognized as the imperative for the political viability of the Euro project. We must have the intellectual honesty and courage to act accordingly.

Tuesday, November 13, 2012

The graph above shows the number of minutes that workers have to work to buy 500ml of beer (h/t to Renata Lins of chopinhofemenino, great blog if you read Portuguese). By the way, a pint in the US is slightly less than that (around 473ml). Note that the amount of time a worker needs to work depends on the price in dollars. So, for example, China is at the bottom of the list, with workers getting to bliss (yep a General Equilibrium concept bitches) in less than ten minutes, because beer is cheap in dollars, not as a result of high wages. Japanese workers, on the other hand, with higher wages, need to work more like 15 minutes because beer is really expensive.

About four years ago, the collapse of Lehman Brothers marked the beginning of the Great Recession. The world is still reeling from the consequences of this all-encompassing financial crisis. What, though, were the causes of the crisis? Much has been said about derivatives, failed regulations and greed. These things matter, but here I would like to offer a simpler and maybe deeper explanation: Globalization forces countries to hollow out their social contracts. Reduced real wages promise gains through investment and exports, but ultimately undermine growth everywhere.

If real wages do not sustain growth globally, what can? The answer is that a global credit bubble—from California and Florida to Spain and Ireland—could, until it couldn’t any longer. The underlying trends ultimately catch up: If real wages do not keep up with productivity growth, the labor share of income is falling. The global credit bubble often manifests locally—for example, as a real estate boom in, say, Miami or on the mediterranean coast of Spain—but is propelled by a liberalized global financial market. Thus we can identify three dominant but interdependent drivers in this story: accelerating globalization, increased inequality and financialization.

To trace out very broadly how we got here, consider post World War II economic history split into two periods: the Golden Age of capitalism of the immediate post-World War II era, which ended with the collapse of the Bretton Woods system in the 1970s, and the second era of globalization, which began with the conservative revolution towards the end of that decade. The Golden Age saw fast global growth, including in developing economies. Trade links between economies strengthened, but integration was not as deep as today. Capital account openness was very limited. In many advanced as well as catching-up economies, welfare states deepened. Expanding labor institutions protected jobs and ensured sharing of rapid productivity growth. Generally, these developments supported the labor share of national income. In that manner, global growth was sustained by local demand.

The second era of globalization, in sharp contrast, saw accelerating globalization. Trade integration deepened substantially, international production defragmented into flexible—“footloose”—transnational production networks, and capital accounts were liberalized. All these trends discipline labor through the very real threat of relocation. Indeed, labor contract negotations that are not subject to a threat of offshoring tend to be the exception, partly due to the increased tradeability of services. As a result, real wage growth has lagged productivity growth in many countries, leading to falling labor income shares and increased inequality. Thus, globally, consumption demand cannot absorb what can be produced: global effective demand is lacking and unemployment and stagnation follow.

Open capital accounts take center stage in this narrative. First, countries need to offer low corporate taxes (if not tax exemptions) as well as low wages to attract and hold foreign direct investment of “footloose” multinationals. These tax policies limit fiscal space of the state to support social safety nets, invest in education, and maintain crucial infrastructure systems. Crucially, financialization in combination with open capital accounts tends to produce volatile, pro-cyclical capital flows, which provide fertile ground for unsustainable credit expansion. Such credit growth often feeds into real estate bubbles and debt-led consumption on the way up, but balance-of-payments crises on the way down. In recent years, specifically, financialization—through the presumed innovation in the use of securitization and derivatives—sustained a global credit bubble that served to postpone the day of reckoning: As long as middle and lower class households in advanced countries maintained standards of living through buildup of debt, growth continued despite the underlying “real” lack of demand.

In summary, accelerating globalization and financialization forces nations to dismantle social contracts and welfare states, to suppress wages and weaken labor standards. In the process, inequality rises, demand lacks, and the community of nations undermines itself. To illustrate the issue, consider a scenario originally concocted by Rousseau: Two men are out to hunt. They are on opposite sides of a hill, and can not communicate. Now, they can set off individually to hunt a hare, which will provide food for a day. Alternatively, they can hunt a stag together, which provides food for several days for both of them. Why not go for the stag, every time? Hunting the stag requires trust and cooperation, and institutions that foster and enforce them.

Similarly, it requires trust and cooperation to institute policies that support a thriving middle class—as during the Golden Age. Simply put, two countries benefit if both institute such policies, because it deepens the extent of the market for goods and services. Globalization has made it increasingly difficult for one country to trust that the other won’t give tax breaks to corporations, won’t undermine real wages, won’t manage its exchange rate, all to increase its share of the existing global market.

Joan Robinson called such untrusting tactics beggar-thy-neighbor policies. Many countries pursues these policies since no global economic or political institutions exist that effectively foster and enforce trust and cooperation. But, market economies must be embedded in a web of socio-political institutions that buffer their disruptive effects. The social democracies of the last century managed to do that, to a degree, for the conditions rendered by the Golden Age. It has become clear that globalization destroyed that model—and that renewed efforts at embedment must be pursued on a global scale. Will that be possible?

PS: Orginally published a slightly different version in Spanish by Página/12 here. The academic version of the argument (co-authored by Daniele Tavani and Laura Carvalho) can be found here.

Monday, November 12, 2012

A fairly interesting meeting of historians of economic thought from Europe and Latin America will be held this year in Buenos Aires. The conference is part of the European Society for the History of Economic Thought (ESHET) activities taking place outside Europe and is the second in Latin America. More info here. Program and papers (or at least most of them) here (h/t Alejandro Fiorito and Revista Circus).

I was at a conference organized by Luis Bértola (November 5 and 6) on the relevance of the economic ideas of Raúl Prebisch at the Economic Commission for Latin America and the Caribbean (ECLAC, pictured above), and the launch of a new website (in Spanish here; the Spanish version is for now more developed, and soon there will be a Portuguese version too) with resources (e.g. this paper on Prebisch's views on central banking and monetary policy, co-authored with Esteban Pérez) on the second (not first) Executive Secretary of that venerable Latin American institution.

In my view, ECLAC has evolved, like most institutions, partly reflecting its internal dynamics, but also reflecting the evolution of the societies in which they are inserted. In that sense, if Prebisch and the push for Import Substitution Industrialization, and also the overcoming of structural heterogeneity (the fact that the structure of production, and the patterns of consumption and exports are not in sync), dominated the first three decades of the institution, Fernando Fajnzylber (classic book here) and the need for external competitiveness were, and to some extent still are, ubiquitous in the subsequent period. The theoretical basis of his ideas, and of a lot of what is done at ECLAC, is heavily influenced by the neo-Schumpeterian School, but some elements of structuralist/post-Keynesian economics, in particular in what respects to the role of the external constraint remains an essential part of the way of thinking in Santiago.

I'll leave for another post the discussion of the problems that I see in the post-Fajnzylber ECLAC and about some of the limitations of neo-Schumpeterian analysis. I want to concentrate on a few points raised by Mario Cimoli, Ricardo French-Davis, Gabriel Porcile and Osvaldo Sunkel. Cimoli and Porcile (with Verónica Amarante) presented the document Structural Change for Equality. Cimoli suggested that this document goes a long way, even if more work needs to be done, to present a coherent view of development, and emphasized that the ideas are not old, démodé (in his own terms). In part, the ideas are fashionable, according to him, because they follow modern approaches, in particular Schumpterian ones. I find that preoccupation and line of discussion to be a feeble defense of scientific value. Theories should not be measured by their popularity. Sure enough there are fashions in science, as in many other fields, but the ultimate criteria for scientific demarcation is logical consistency and supportive empirical evidence.

Other than that Cimoli suggested that the problems of structural heterogeneity are still with us. Gabriel Porcile presented the macro part, and emphasized the limits associated to the balance of payments, which are to some extent related to the real exchange rate (in this part Amarante presented the numbers on income distribution, including functional income distribution, which I shall comment on another post). He also suggested, I think quite correctly, that Thirlwall's Law, had been in many respects anticipated by Raúl Prebisch.

As the title shows, there is not much that is new in the new report (the 1990 report, based on Fajnzylber ideas, was called Changing Production Patterns with Social Equity). The idea is that external competitiveness (the changing productive patterns and the structural change in both titles) could be achieved without reducing wages (the equity and equality in the titles), and that industrial policy is essential for that goal. What is worrisome to me is that on macroeconomic issues the document seems to be a bit too conventional.

"Financing changes in the production patterns naturally calls for some reorganization of fiscal policy in order to increase, public savings that can be used for investment. Every effort should be made to prove the allocation of expenditure, but it seems clear that most of the fiscal adjustment must be through tax reform."

In other words, fiscal adjustment. Now (p. 169 in the current Report) they suggest:

"Implementing a countercyclical fiscal policy involves two major challenges. The first is to create enough fiscal space to undertake the extra spending necessary to boost aggregate demand and economic growth during the contractionary phase of the cycle. This extra fiscal space can be generated by increasing public saving during the boom phase so that the impact of adverse shocks can be absorbed without jeopardizing the financial sustainability of the State."

So now they only ask for fiscal adjustment during the boom phase, moderating the growth in that part of the cycle, but admit that counter-cyclical policies have been effective in the recessive phase. Note that this conclusion might conflict with the ideas put forward on chapter 3 on the business cycle in the region. The document (p. 100) says that:

"It shows that the Latin American and Caribbean region tends to have truncated expansion phases and that they tend to be shorter than in other regions."

But it does not suggest that the causes might be related to macroeconomic policies, including overly restrictive fiscal policies in the boom. It rather suggests that:

"Short expansion cycles reflect the inability of the production structure to transform the momentum of demand growth into sustained endogenous economic growth (through linkages, spillover effects and virtuous circles)."

The paper by Pérez and Pineda (2010), which I had discussed here before, seems to suggest that macroeconomic policies (and the demand side) might be more important than supply side conditions in explaining the poor Latin American performance during booms. Finally, two brief comments about French-Davis and Sunkel's talks. French-Davis noted that the region is extremely vulnerable to a collapse of the terms of trade and thought that there are no structural causes for higher commodity prices. Sunkel suggested that in some countries, and he presented some data on Chile, there is a consumption boom, based on credit, which also puts at risk the expansion in the region. More on those two propositions on another post.

Friday, November 9, 2012

In the tense run-up to Hurricane Sandy, I clicked on one of those headlines that appears on the right side of the screen: “Civilization May Not Survive This, Economist Says.”

Once there, I knew I’d been had. It was about … the public debt. It cited one Lawrence Kotlikoff of Boston University, one of America’s most talented artificers, who “estimates the true fiscal gap is $211 trillion when unfunded entitlements like Social Security and Medicare are included.” Compared to that, what’s a thousand mile-wide hurricane?

Tuesday, November 6, 2012

Today the United States will choose between a moderate Republican, with a pro-business agenda, or Mitt Romney. Yes President Obama has saved the economy from a 1930s like catastrophe with a smaller than necessary, but still very effective, fiscal package, and monetary easing has precluded a collapse of the banking and financial sector like the Great Depression one, but his economic views and the outlook of his policies remains to the right of Richard Nixon. Obama did not disagree with Mr. Romney that government does not create jobs, and has accepted the anti-Keynesian rhetoric of the need of reducing the fiscal deficit, even though the recovery, which is undeniable, has been very slow.

Monday, November 5, 2012

In my last post I briefly discussed the Austrian approach. One interesting point, discussed in more detail in the comments, is that several Austrians do not understand that they are neoclassical. Note that the core of neoclassical economics is the determination of prices, initially at least it was long-term prices, by the interaction of supply and demand.

I find a bit surprised that several neoclassical or marginalist economists do not understand the basics of their own theory. This confusion is compounded by the fact that several heterodox economists do not understand it either, and tend to be confused, as a result, on how they depart (when they do) from the mainstream.

I'll give you an example. If you think that prices (long-term normal prices, for those that think that these are analytically important) are determined by supply and demand, then you basically must believe that (with the exception of rigidities and other imperfections) full employment is the natural tendency of the system. Note that if prices are determined by supply and demand, the real wage in the long run would be determined by the supply and demand in that market, and given productivity and preferences you get full employment at the equilibrium real wage.

The failure of some mainstream and heterodox economists to understand the neoclassical approach, in my view, stems from the collapse of the marginalist project after the capital debates (not of its dominance, but the ability to provide coherent responses to the critics). Robert Vienneau has a very good post on the failure of neoclassical economics. Worth reading.

Friday, November 2, 2012

This is not a topic I would normally write about. In particular, because I do not think Hayek was a particularly relevant theorist, even within the mainstream. By the way, that's the reason why within the neoclassical/marginalist school Austrians are sort of marginal. Note that marginal means that they are in the minority, but by no stretch of the imagination Austrians should be seen as heterodox [this is prove that Wikipedia, if you have doubts, is not entirely reliable. Again proper definition of heterodoxy means accepting that distribution is exogenous, and prices do not reflect relative scarcities, and that output and employment are demand determined in the long run, both positions that the Austrians would not accept].

But I got a few questions about Austrians and I think it is important to make one thing clear about their theory of business cycle, namely: it is not particularly different than mainstream theories, and is fundamentally Wicksellian in outlook, whether Austrians get it or not. There should be little doubt that Hayek believed that fluctuations were caused by monetary shocks, and that equilibration was based on the adjustment of a monetary rate to a natural rate [Remember his debate with Sraffa? One of the key issues in Sraffa's critique of Hayek was that he argued that latter's claim that the possibility of a difference between own rates of interest and thus a divergence of some rates from the equilibrium or natural rate is a characteristic of a money economy that is absent in a barter economy was simply wrong since there was no unique natural rate of interest from which the money rate could differ].

Even if you add his stuff on uncertainty, which many believe is close to post-Keynesian analysis, there is little in Hayek that departs from the basic Wicksellian framework [interestingly the Keynes of the Treatise shares that framework]. I should mention here that if you read Paul Davidson carefully, you would note that his concerns about fundamental uncertainty are basically related to lack of demand. When he tells you that firms do not hire workers for a lower wage unless they have demand, that means that government spending can reduce uncertainty very swiftly.

The only interesting Austrian is probably Schumpeter. Schumpeter, in contrast to Hayek, and like Wicksell, believed in real shocks, not monetary ones. Mind you, he was more interested in the sort of long term shocks caused by innovation. Still the framework is very similar, and Wicksellian in the fundamentals. Real shock (innovation) causes the spark for growth, diffusion eventually erodes the advantages of the innovators and the boom winds down. The economy moves from one circular flow, with the economy in Walrasian equilibrium to another one. So Schumpeter too is at core part of the marginalist tradition, as all Austrians are.